Real Estate, Technology
and the Rentier Economy:
Pricing in excess of Value,
producing Income without Work
Michael Hudson
[A speech delivered at "The Economics of
Abundance" conference, held at King's College, London, 3 July,
2006]
Simon Patten coined the term "economy of abundance." He was
the first professor of economics at the nation's first business
school, the Wharton School of Business at the University of
Pennsylvania.[1] Like the other founders of the American Economic
Association, he was trained in Germany, where he described economic
teaching as culminating with the writings of John Stuart Mill. But as
Patten later observed, Mill became more reformist and even socialist
after revolutions swept through Europe in 1848. His liberal philosophy
was "not a goal but a half-way house" between classical laissez
faire and more activist schools of economic reform fueled by class
conflict in the face of the Industrial Revolution's squalid urban
poverty. "The Nineteenth Century epoch ends not with the theories
of Mill but with the more logical systems of Karl Marx and Henry
George."[2]
George opened Progress and Poverty by posing the question of
why there still was so much poverty in the face of the Industrial
Revolution's remarkable explosion of productive power. Today, many
economists are asking a similar question: How can GNP be rising at
about 4 percent a year in America while real wages have been drifting
downward since 1979? Where are the fruits of productivity going?
Suppose someone at the end of World War II in 1945 had been informed
of the remarkable technological breakthroughs that have occurred over
the past 60 years - the advances in medicine and pharmaceuticals,
genetics, air and even space travel, communications, computers and
information processing, atomic power, and a better ecological
understanding of how our planet works. The expectation would have been
for a leisure economy in which citizens could devote themselves to
better educational and cultural pursuits. At least, this was what
futurists promised, decade after decade as they looked at the great
potential of technological progress.
The question is, why haven't these rosy pictures materialized? Why
are employees working longer than ever before, with many couples
holding three jobs between them?
George's answer was that rent - and rising land prices - was
diverting the economic surplus away from capital formation and
consumption, exploiting both capital and labor. But the problem does
not stem only from of land-rent. The most notable examples of prices
and incomes without corresponding (necessary) costs of production are
finance and insurance, whose interest, commission and policy charges
are set independently of costs. And much of what passes for industrial
profits actually consists of monopoly rent and "intellectual
property rights." These rents are highest in areas where
productivity and technological breakthroughs since World War II have
been largest and were expected to bring society the greatest benefits.
Analyzing growth in labor and capital productivity, William Baumol he
has calculated that innovation carried out since 1870 accounts for
nearly 90 percent of today's GDP, including even the "steam
engine, the railroad, and many other inventions of an earlier era."[3]
But the Forbes lists of the world's wealthiest people shows the degree
to which most wealth today consists of rent-yielding property. The
Federal Reserve's reports on "Balance Sheet of the U.S. Economy"
(Table Z of its quarterly flow-of-funds statistics) show that real
estate remains the economy's largest asset, and further analysis makes
it clear that land accounts for most of the gains in real estate
valuation. Most of the remaining U.S. wealth consists of other
monopolies - fuels and minerals, the broadcasting spectrum, Microsoft
and kindred intellectual property rights.
Technology has become an intellectual property right, permitting its
owners to charge economic rent. The pharmaceuticals industry has been
among the greatest abusers. The DNA code and even long-known Chinese
herbal cures are being patented into "intellectual property."
And no companies are more notorious than the HMOs - "health
management organizations" that have interjected themselves as a
skimming operation between patient and doctor. Broadcasting companies
have privatized the electromagnetic spectrum rights originally and "naturally"
in the public domain. Meanwhile, the phone and cable companies are
trying to create tollbooths for the Internet, much as Microsoft has
become the major rent collector for information processors. The stock
market's major "industrial" growth areas turn out to be
examples of economic rent, although these "super-profits"
take the form of profits and dividends ostensibly produced by capital.
Stock-market speculation today is largely a rent-seeking activity as
companies are raided for their land or other property income. Retail
food stores in particular have become land plays. Earlier this year,
corporate raiders wanted McDonald's to mortgage the land value of its
restaurants and pay out the loan proceeds as dividends. This raid
illustrates how today's real estate bubble itself is largely a
financial phenomenon. The upshot is that on the mortgage banker ends
up with most of the net groundrent. Since World War II, interest
charges have absorbed the increase in real-estate rent as a proportion
of U.S. national income, just as interest is absorbing a rising share
of industrial cash flow and consumer income.
Rentier income - economic rent and interest or other financial
charges - are the major factor polarizing the U.S. and other
economies. This polarization of wealth and income is just the opposite
from what the classical economists and Progressive Era reformers hoped
to bring about. A study for the Congressional Budget Office recently
showed how sharply the maldistribution of rentier income has
increased in recent years, largely as a result of lowering tax rates
on capital income and capital gains. "In 2003, the top one
percent of the population received 57.5 percent of all capital income."
This was the highest proportion since the CBO began collecting data in
1979 - which also happened to be the year in which real wage levels
peaked. At that time the top one percent of the population received "only"
37.8 percent of capital income, and the top ten percent two-thirds
(66.7 percent), compared to nearly four-fifths (79.4 percent) in 2003.
The Center on Budget and Policy Priorities concludes: "Extending
lower tax rates on capital gains and dividend income would exacerbate
the long-term trend toward growing income inequality."[4] So the
concentration of rentier income is largely the result of
regressive tax policies replacing the progressive taxes that existed
prior to the 1970s.
The wealth created by the past century's technology and basic means
of production thus is not accruing to society as a whole, but to the
topmost 1 percent of an economy that is polarizing increasingly,
thanks to today's asset-price inflation. Prof. Baumol provides part of
the explanation in an article contrasting productive with unproductive
ways of gaining wealth.[5] Expanding Joseph Schumpeter's
categorization of innovations in terms of new modes of manufacture,
marketing or economic organization, this article adds "acts of
'unproductive entrepreneurship'" such as "innovations in
rent-seeking procedures, for example, discovery of a previously unused
legal gambit that is effective in diverting rents to those who are
first in exploiting it," e.g., the creation of monopolies and
means of acquiring them or increasing their ability to extract
economic rent from the economy. Other examples might include property
speculation, corporate raiding, greenmail and leveraged buyouts.
The bulk of this rentier income is not being spent on
expanding the means of production or raising living standards. It is
plowed back into the purchase of property and financial securities
already in place - legal rights and claims for payment extracted
from the economy at large. Most rental income and interest is
channeled back into the property and stock market to buy more
rent-yielding real estate or ownership rights. This inflates prices
for these assets, making property and financial speculation more
attractive than new capital formation. The economy shrinks, in much
the way that Ricardo warned would occur as a result of groundrent
diverting revenue from industry to landlords. Except in this case,
revenue ends up being diverted into the financial sector.
To see how great a sea change has occurred, we must return to the
Progressive era and ask what happened to its ideals. Like the great
classical liberals, the Progressive Era sought to regulate monopolies
and other would-be rent grabbers so as to prevent price gouging, and
to tax away land rent and "super-profit." Progressive
muckrakers also emphasized the role of finance, especially Wall
Street's role in squeezing out economic rent to pay bondholders and
stockholders while insiders "watered the stock" with
financial skimming and other rent-grabbing activities organized by
financial manipulators, railroad barons and other privatizers.
The foundation of classical economics was the doctrine of economic
rent, a "free lunch" defined as the excess of market price
over the necessary costs of production ("value," which
ultimately could be resolved into labor costs, including the cost of
labor embodied in the capital equipment and other materials used up in
production). Rent was unearned, because it was revenue with no
corresponding cost of production to justify it morally or
economically. What is economic rent and rentier income,
and why is it deemed to be "unearned"?
It is now nearly two centuries since David Ricardo defined economic
rent as the margin of market price over cost-value, a free lunch
flowing most conspicuously from land ownership. In Chapter 2 of his
1817 Principles of Political Economy and Taxation, Ricardo
extended the concept of economic rent to other natural monopolies. He
cited mining as the most obvious, but the phenomenon extends to legal
giveaways such as the broadcasting spectrum, and to artificial
monopolies granted by patents and "intellectual property rights"
ranging from Walt Disney cartoon characters to pharmaceuticals and
computer software programs.
Ricardo developed the concept of economic rent to urge Britain to
import low-priced food from abroad. The alternative, he warned, was
for landlords to siphon off the fruits of the Industrial Revolution's
productivity gains. In the absence of free grain imports, population
growth would force resort to less fertile soils, forcing up British
food prices and hence the basic living wage. Owners of the most
fertile lands would benefit from rising crop prices, while employers
would be faced with rising labor costs, pricing them out of world
markets. High rents would squeeze industrial profits and deter capital
investment, making society poorer. But free trade would prevent the
emergence of a widening margin of economic rent - the difference
between high-cost and low-cost food producers. More radical followers
- the "Ricardian socialists" and "philosophic radicals"
- saw economic rent as a property right that was itself exploitative,
a right obtained originally by military conquest and what Marx called
"primitive accumulation."
In today's family budgets, housing charges have grown to exceed
spending on food. In June 2006, the Bureau of Labor Statistics
released a century-long profile of New York City family budgets. In
1900 food, drink and tobacco dominated family spending, absorbing some
43 percent of family budgets. Today, that proportion is down to 13
percent. In 1900, housing accounted for only about 15 percent of
family budgets - just one sixth of family income. Today, that
proportion has risen to 38 percent. Urban landlords thus have replaced
the agricultural landowners whom Ricardo depicted as the major rent
recipients, while the gamut of economic rents has broadened to include
transportation, communications and other natural monopolies, patents
and related property rights. These rents create prices "empty"
of actual cost-value. They are a margin over necessary production
costs, siphoning off income otherwise available for spending on goods
and services.
Finance has become a growing part of the problem. Absentee owners buy
property rights on credit, pledging the rental income to pay the
mortgage interest, in accordance with the motto "Rent is for
paying interest." Equilibrium is reached when the winning bidder
for a property pledges to pay all the free rental income (after costs)
to carry the mortgage. The banker gets the rental cash flow, while the
real estate owner is willing to settle for a chance to get a capital
gain.
The real estate game thus becomes an exercise in borrowing money to
ride the wave of asset-price inflation - "capital" gains
that John Stuart Mill called the "unearned increment." The
same has become true for other rent-extracting enterprises, including
pharmaceutical and broadcasting companies with special monopoly,
patent or "intellectual property rights.
In search of asset-price gains, corporate raiders and other empire
builders issue high-interest "junk" bonds, pledging
corporate earnings to cover the interest charges. Our tax system
encourages this debt pyramiding by permitting interest charges to be
tax-deductible. The effect of buying property on credit is thus to
shield rental income exempt from taxation. Instead of accounting
for the bulk of taxation as advocated by the classical liberals and
Progressive Era reformers, taxes on rental income and land-price "capital"
gains are declining. The growing political power of rentiers
enables them to shift the tax burden onto labor and industry.
This is not how the classical economists expected matters to work
out. Their ideal was an economy in which public revenues would come
from rental charges in the character of user fees for land sites,
subsoil mineral resources, transportation and communications
infrastructure and other parts of the public domain that were natural
monopolies - not from taxes on wages, profits or sales. These were the
policies that went under the label of Progressive - a land tax to
collect economic rents, anti-monopoly regulation, and a credit system
to finance industrial capital formation rather than to operate
parasitically. The reforms they envisioned a society in which incomes
would be earned mainly by productive work and enterprise to earn
profits and wages, not rent and interest. Prices would reflect the
necessary costs of producing goods and services, free of economic rent
- that is, free of rentiers siphoning off income simply from
property rights and monopoly rights. The harder one worked, the richer
one could become.
Democratic political reform was intended to create a fiscal and
regulatory system to check the rentier power of property and
finance. The failure to achieve the classical and Progressive Era's
economic reforms is thus as much political as it is economic. Much of
the explanation is that the financial and real estate interests have
promoted a self-serving economic ideology and body of theory. Bankers
in Ricardo's day, for instance, threw their support behind industry
rather than protectionist landlords because they viewed free trade as
enhancing what had been their major business since early medieval
times: financing international trade and investment. But they later
shifted their allegiance to the landlords and monopolists who became
their major customers.
Economic dystopia vs. the Economy of Abundance
Today's economies are evolving on a diametrically opposite path from
that mapped by liberal reformers from Adam Smith through Mill and his
successors. The post-classical counter-revolution pretends to stand in
the classical tradition by calling themselves neoliberals. But almost
without anyone noticing, it has turned the meaning of liberal reform
inside out. Rather than taxing
rentier wealth and its income, it has promoted real estate and
financial interests.
The classical reformers defined their politics as liberal because
they wanted to free the economy from "empty" rentier
charges, price without value. Their objective was an economy in which
everyone's income would reflect the productive contribution they made.
Their opponents - who misleadingly call themselves neoclassical - have
promoted a myth that this will happen automatically, if only
governments will refrain from "intruding" into the economy.
An over-simplified, ostensibly free-market image depicts "market
forces" as steering savings into areas that best serve the needs
of consumers and promote economic growth. The reality is that the
failure to regulate markets has led to debt-financed property
speculation and a travesty of "wealth creation."
In the post-classical view, all income and wealth is earned. Economic
rent is conflated with profit, which is supposed to fairly reward
innovation and enterprise - and the willingness of businessmen to take
risks. The logic is much the same as that which underlay the Churchmen
of the 13th century, justifying the banker's interest and the
tradesman's profit by the cost of their own labor time plus an
adjustment for the risk of losing their money. Nothing is said about
unearned income - the economic rent that classical liberals defined as
that element of price that could not be resolved into costs of
production, costs that ultimately were resolvable into labor
(including the labor embodied in the machinery and other capital goods
used up in production).
The classical reformers viewed less inequality as a precondition for
sustained prosperity. They expected democratic reforms to promote
greater equality and prosperity, by leading to land taxation and
regulation of monopolies as populations voted their enlightened
economic self-interest. But the vested rentier interests
mounted an economic and political counter-reformation, claiming that "the
market" will enable everyone to earn what they deserve - that is,
the "service" they contribute to production, without any
need for progressive tax reform or public regulation.
The assumption underlying this value-free doctrine is that no income
or wealth is unearned. Property distribution and rentier
claims are "externalities," that is, extraneous to the
production of goods and services. This narrow approach exiles
Thorstein Veblen and other "institutionalists" to the
academic basement discipline of sociology - at the price of unseating
classical political economy from its position as queen of the social
sciences to become merely "economics," focusing on supply
and demand without paying much attention to how rent and interest
claims enter into the costs of doing business and divert income away
from being spent on goods and services.
In many ways we are living in what the classical economists would
have deemed to be a dystopia. Fewer people are able to earn enough to
own their homes free and clear, or save enough to retire or pay for
medical care - except for the miniscule number who lucky enough to win
lotteries. A reported 68 percent of U.S. workers say they are
confident that they will be able to live comfortably after retirement;
but 53 percent have saved less than $25,000.[6] An equally unrealistic
number of people imagine that through hard work they have a chance to
become millionaires, a postmodern illusion that will doom most people
to a life of frustration.
The reality is that the economy is tilted to favor property owners,
monopolists and creditors at the expense of those who produce goods
and services. A widening share of national income is going to
landlords, creditors and other rentiers at the top of the
income and wealth pyramid, increasingly free of taxes. The wealth that
produces these rentier incomes is not real capital investment, nor is
it technological. It is created by law, often by stealth and insider
dealing.
Much as the Ricardian free traders opposed Britain's protectionist
landowners, so the Progressive Era's reforms aimed at preventing
railroad barons, Standard Oil and the mining trusts from charging
extortionate prices that had no counterpart in necessary costs of
production. The alternative was to let rentiers maximize
economic rent, that is, "empty" pricing without cost value.
The Progressive response to such price gouging was threefold:
progressive taxation of wealth, anti-monopoly regulation to ensure
fair competition, and public investment in infrastructure monopolies
to provide their services at cost. The aim was for public regulation
and taxation to bring prices into line with necessary costs of
production, keeping basic prices low and hence making domestic labor
and capital internationally competitive. Economic liberalism -
opposition to rent as a free lunch - thus went hand in hand with an
advocacy of national competitive power.
The largest capital expenditures for the leading industrial economies
are natural monopolies - transport systems, mineral-bearing land, gas
and electric power, communications and the radio spectrum. These are
areas where competition cannot be relied upon to bring market prices
down to costs, because it does not make economic sense to invest in
competing railway or streetcar lines, in canals, power transmission
lines and so forth. For this reason most European countries kept these
natural monopolies in the public domain, and the United States
organized them as regulated public utilities. Yet most economic
textbooks depict industrial capitalism primarily as consisting
primarily of manufacturing - steel, autos, consumer goods and other
sectors in which technological innovation has steadily cut costs,
reducing prices accordingly.
For the past century a guiding principle of public regulation has
been to limit economic rent by bringing market prices into line with
actual production costs. But privatizing natural monopolies and
creating new property rights brings into being a constituency to "create
wealth" by gouging rent from the economy at large. The way to
successfully oppose this policy is to spread an awareness that an
enormous part of the nation's wealth - and the income it siphons off -
is not actually earned but is a free lunch - income that landlords
collect "in their sleep" as Mill put it, without any effort
of their own.
The classical economists recognized that economic rent will exist as
long as production costs and the desirability of sites vary.
Increasingly, they focused on what Heinrich von Thünen called the
rent of location. Well-situated land is more valuable than properties
situated further away from the economic centers, requiring more time
and transport costs of access. This shifts the focus of property rent
away from agriculture to urban real estate, the largest element in
today's national balance sheet of assets - and of the mortgage debts
attached to them. But most important is the fact that economic rent
occurs increasingly in the sphere created by privatizing monopolies
hitherto in the public domain, and granting monopoly rights to
technology itself.
Economic rent in industry
Whereas Ricardo based his concept of rent on diminishing returns, the
American School of economists emphasized increasing returns. They saw
low-cost producers obtaining super-profits - economic rent - by
technological innovation. In much the same spirit, Joseph Schumpeter
based his theory of business cycles on innovators and emulators. In
his optimistic view, the advantages of rising productivity would be
merely temporary as knowledge spread and competition ironed out what
Alfred Marshall had termed the "quasi-rents" that early
leaders achieved.
This free-market logic did not apply to monopolies, or to the
financial sector adding its own debt overhead. The late 19th century
coined the term "watered costs," referring to
technologically unnecessary charges for interest and dividends, often
paid to corporate insiders who watered the stock by issuing bonds to
themselves and their political cronies. But nobody a century ago
anticipated anything like the recent attempts to use the patent laws
to create rent opportunities in information technology, communications
and pharmaceuticals. The traditional feeling has been that technology
should be universal, so that competition would be in production and
distribution, not in establishing property rights as the basis for
access fees.
The claim often is made that at least economic rents in industry are
earned. The objective of advertising, for instance, is to create "consumer
loyalty" to limit choice to specific brand names. Rather than
just "giving the public what they want," advertising creates
wants,
e.g. on Saturday morning TV pushing sugared cereals to
children.
Despite the fact that much of what is reported as "profit"
is more technically a rental or "access" fee, no statistics
are reported on economic rent as such. But it is obvious that drug
company and tobacco profits represent economic rent far in excess of
production costs, which are mainly legal and political, not
technological. Broadcasting profits result largely from early free
appropriations of the airwaves from the public domain. For Internet
sites, one might cite E-Bay, Amazon.com, Expedia and Orbitz for air
travel. Their revenue stems largely from the head start they achieved
by heavy investment in the information-rent economy's early years.
As Patten, explained, the appropriate measure of success for public
infrastructure investment in natural monopolies was its ability to
lower the economy's cost structure. The Erie Canal, for instance,
brought grain from the Western states to upstate New York, minimizing
local farm rents and hence lowering the economy's basic costs of doing
business. To seek as high a profit as the market would bear, as in the
case of private investment seeking to maximize profit, would make the
rent-burdened economy uncompetitive. Even in the private sector, as
Schumpeter showed, great business booms tended to result from
cost-cutting industrial innovations.
By freeing industry from having to pay rents to monopolists, public
infrastructure investment increased industrial profits for the economy
at large. This is why the Interstate Commerce Commission put an end to
the watered financial charges imposed by the railroad barons, and why
the Sherman Anti-Trust Act of 1890 was used to break up Standard Oil.
But finance managed to become the great sponsor of rent-seeking
activities, and ends up with the rent in the form of interest charges.
The 19th century did not anticipate this practice of using rent to
pay interest. The property-and-rent system now is wrapped in the
financial system. This reflects Patten's principle that if societies
close only one kind of rent-yielding activity, the revenue that is
freed will be grabbed by other monopolies or rent-seekers, or their
financial backers. The idea is to erect barriers around knowledge,
then to charge for access, and then to "financialize" the
idea by issuing stocks and taking out loans, that result in paying out
the rent in the form of interest payments to the bankers and
bondholders.
This turns the post-industrial "service" society into a
neo-rentier economy. Euphemized as a post-industrial "knowledge
economy," it is based on "intellectual property," one
of the most pernicious examples of rent seeking. The recent 2006 court
case against Blackberry's maker, Research in Motion, implied that one
can patent an idea as vague as getting e-mail on cell phones. A
company obtained a patent on this idea, without any specific way how
to implement it, and then sued Research in Motion for patent
infringement. The effect of such patents is to impose rake-off fees
that make technology more costly, thereby undoing its productivity
benefits. The next logical step along this path, economists warned,
would be for some company to patent the idea of peanut butter and
jelly sandwiches and start charging everyone who made them.
Walt Disney is credited with lobbying hardest to extend the lifetime
of copyright protection. The consequence has been to block publishers
from reprinting books (and CD companies from republishing musical
performances) hitherto in the public domain. Critics of such
rent-grabbing follow the classical economists in urging bioengineering
and the genetic code, along with similar "intellectual property,"
to be in the public domain so as to minimize the cost of economic
progress and innovation. But phone and cable companies presently are
seeking to erect toll booths throughout the Internet, prompting one
journalist to write: "The nation's largest telephone and cable
companies are crafting an alarming set of strategies that would
transform the free, open and nondiscriminatory Internet of today to a
privately run and branded service that would charge a fee for
virtually everything we do online."[7]
The classical response is to tax away all economic rent, so that it
cannot be paid out to creditors or taken by rival rent-seekers. The
objective is to minimize prices, not raise them. However, the
financial sector has gained control of public policy and cut taxes on
wealth, capital gains and the higher income brackets, knowing that
what the tax collector relinquishes is available to be pledged as
interest payments on larger loans to buy rent-yielding properties.
Rent seeking thus finds its counterpart in asset-price inflation.
To deny the distinction between rent and profit, and between property
rights and tangible capital, is a travesty of what 19th-century
liberalism was all about as a political program. Today's
self-proclaimed neoliberalism leads to economic polarization
counterpoising property owners and their financiers to industry and
labor. The danger is that as rent generates more revenue than does
profit, rentiers will be able to convert their economic power
into political power. This already has happened in the international
sphere, where the World Bank and IMF have imposed the Washington
Consensus, directing debtor governments to sell off public monopolies,
on terms that do not tax or regulate their economic rent but leave
this in private hands, including those of foreign creditors.
Conclusion
How do we achieve the Economy of Abundance that seemed to inevitable
a century ago, and so within reach as recently as the 1950s? Why have
people not obtained the leisure promised by the technology that recent
generations have achieved?
The problem is not technological, given the scientific breakthroughs
achieved since World War II in medicine and biology, transportation
and communications, atomic power and computers. Rather, the problem is
that rent and debt charges have absorbed the surplus, siphoning off
income from the production-and-consumption economy and steering this
revenue - and new credit creation - to inflate prices for
rent-yielding property and financial securities.
As legal property rights, rent-yielding assets are not means of
production. They do not add to output, but intrude into the economy,
by siphoning off income for rights-holders. This extraction of income
is in the character of economic rent. And matters have been
complicated by the fact that these rights and their rental income
streams are bought increasingly on credit. In fact, most credit today
is created to finance the purchase of these rent-yielding assets, not
to buy goods and services. Yet monetarists relate the money supply
only to consumer and wholesale prices, not to the property and
financial transactions that absorb more than 99 percent of payments.
This is the essence of what Thorstein Veblen described as absentee
ownership a century ago, when the financial and real estate sectors
were merging.
To counter this anti-progressive dynamic, it is necessary to draw
peoples' attention to the rent problem by showing its order of
magnitude. This requires quantifying economic rent, and demonstrating
that not all income and wealth are earned. "Wealth creation"
that takes the form of rising prices for rent-yielding property is not
the same thing as tangible capital formation. Indeed, a
rentier economy's "free lunch" dynamics are
antithetical to rising productivity and living standards. The basic
principle is that rent is unearned. Income and wealth obtained at
other peoples' expense should be the basic source of taxes, not the
labor and capital needed to produce goods and services.
This economic doctrine was widely accepted a century ago. It led
Thorstein Veblen to extend the Progressive era's critique of
rent-extraction into the broader sphere of absentee ownership - which
became the title for his 1923 book, Absentee Ownership and
Business Enterprise in Recent Times. Already from the 1890s, in
fact, the Progressive Reformers focused on Wall Street and other
financial centers for loading down prices with "fictitious"
costs (what George called "fictitious" capital, whose income
he classified as "value of obligations" as opposed to "value
in production" in his posthumous Science of Political Economy).
Value of the one kind - the value which constitutes an
addition to the common stock - involves an addition to the wealth of
the community or aggregate, and thus is wealth in the
politico-economic sense. Value of the other kind - the value which
consists merely of the power of one individual to demand exertion
from another individual - adds nothing to the common stock, all it
effects is a new distribution of what already exists in the common
stock, and in the politico-economic sense, is not wealth at all. . .
.
Value arising in the first mode may be distinguished as 'value from
production,' and value arising in the second mode may be
distinguished as 'value from obligation' - for the word obligation
is the best word I can think of to express everything which may
require the rendering of exertion without the return of exertion.[8]
In other words, "value from obligation" was that element of
price that could not be resolved into labor costs of production
(including the labor embodied in capital goods used up in production).
When Teddy Roosevelt ran to regain the presidency on the Bull Moose
ticket, he announced at his 1910 "New Nationalism" speech at
Ossowatomie, Kansas: "At many stages in the advance of humanity,
this conflict between the men who possess more than they have earned
and the men who have earned more than they possess is the central
condition of progress." To understand this conflict, it is
necessary to distinguish between earned and unearned income, and to
restore the classical distinctions between productive and unproductive
investment and debt.
A few modern economists have pursued this line of thought. Examining
the course of economic history for examples of destructive wealth
seeking, Baumol (cited in fn. 5) finds Rome to represent the most
egregious example of unproductive entrepreneurship. "Persons of
honorable status had three primary and acceptable sources of income:
landholding (not infrequently as absentee landlords), 'usury,' and
what may be described as 'political payments,'" that is, the
power to extort that went with political office in Rome and its
colonies. Turning to modern times, he concludes: "Today,
unproductive entrepreneurship takes many forms. Rent seeking, often
via activities such as litigation and takeovers, and tax evasion and
avoidance efforts seem now to constitute the prime threat to
productive entrepreneurship." Examples include "the
spectacular fortunes amassed by the 'arbitrageurs' revealed by the
scandals of the mid-1980s." But fortunately, "tax rules can
be used to rechannel entrepreneurial effort."
Creditors were the bane of Rome's economy, reducing over a quarter of
the population to debt bondage. The financial sector has a similar
complicity in today's economic polarization, burdening the economy not
only with its own interest-bearing debt but also supplying the credit
to bid up property prices. Rising property rents, monopoly rents and
other rents - and asset prices for these rent-yielding property rights
- increase living costs and make economies less competitive. This has
not deterred the financial sector from backing them, as long as it
ends up with rents in the form of interest charges on the credit
advanced to finance their purchase.
It also is necessary to demonstrate the "Patten principle":
If only one monopoly is regulated or ended, others will take the
economy's available surplus as rent, unless the rental margin is
taxed. This requires a multi-front taxation of economic rent in all it
forms. It is futile just to tax landlords while leaving a surplus for
better-entrenched monopolists to siphon off.
Most important, it is necessary to understand the financial system's
role in making our economy more dysfunctional. Rather than evolving to
serve the needs of industrial growth, banks and other financial
institutions now create credit mainly to inflate the price of property
already in place - especially monopolies - while loading the economy
down with debt charges. The latter problem was recognized already in
Ricardo's day by the followers of Comte Henri de St.-Simon in France,
and subsequently by other continental European and even some British
bank reformers. By contrast, Anglo-American monetarist philosophy
exemplified by Alan Greenspan and other financial "free market"
advocates treats asset-price inflation as "wealth creation"
on a par with tangible capital investment. This deliberate confusion
supports a lobbying campaign to obtain tax breaks for real estate,
monopolies and other major bank clients.
The antidote is to restore the classical economic doctrine, and to
inform the public of the counter-revolution mounted by rentiers
- the financial interests as well as real estate and monopolies. A
basic distinction needs to be drawn between market price and
underlying cost-value - a margin that includes "watered costs."
The word "rentier" needs to be re-introduced to
public policy discussion, along with a vocabulary expanded to include
"economic rent," "unearned income," "windfall
gains." These terms were well understood a century ago. Their
disappearance from public discourse is the result of a
public-relations campaign mounted by the vested interests to replace
classical political economy with "junk economics."
Ultimately at issue is the direction in which economic evolution will
take. Victory is not assured, because as Ecclesiastes put matters, the
race is not always to the wise or the swift. The fall of Rome as a
result of monopolization of the land by an aggressive but
self-destructive creditor class stands as a warning that there is no
guarantee that society will elect to prevent economic polarization in
which rent-takers appropriate the surplus and bring growth to a halt.
This was the economic doomsday scenario against which Ricardo warned.
But his own blind spot was his own banking class and its financial
rake-off. He wrote nothing about how interest and other financial
charges were like groundrent in adding to price without adding to
value. Today, we are in a position to draw a more comprehensive
picture.
There are two kinds of future. One is a rent-seeking society whose
tendency is to maximize gouging by turning everything (even
peanut-butter-and-jelly sandwiches) into a monopoly and charge people
the maximum, namely, all the income they have over and above bare
subsistence levels.
This is what happened in Rome, and we all know what happened to it.
Similar dynamics are beginning to occur in today's world. The
post-modern twist is that rent-gouging activities now are pledged as
collateral for loans for buyers to acquire on credit, in exchange for
turning rent into interest. As the financial sector has become the
ultimate recipient of rent, it has transformed its economic power into
political power demanding that rent-yielding assets remaining in the
public domain must be privatized, that is, sold to absentee owners on
credit.
Opponents of classical liberalism promise that free financial markets
ensure that people "earn what they deserve" even without
progressive tax reform. This is supposed to be automatic. By contrast,
the classical economists saw that truly non-exploitative, productive
markets needed careful regulation to prevent special interests and
monopolies from distorting prices and incomes. The 19th century's
economic liberals thus produced the ideals of progressive taxation and
a fiscal focus on economic rent and other unproductive income.
The scenario outlined by classical economic liberals and the
generation of Progressive Era reformers who followed in their train
was for natural monopolies (implicitly including pharmaceuticals and
health care, the internet and computer programming, and other
intellectual property) to be retained in the public domain or, at the
very least to be regulated and taxed as public utilities so that
prices reflect costs. Otherwise, what is not paid to the tax collector
simply will be paid to the bankers and bondholders advancing the
credit to buy these property rights.
So we are brought back to the classical theory of economic rent and
its taxation. Just as it formed the policy core of classical
economics, it needs to be applied and quantified today as the
foundation for policy reform designed to channel society's economic
surplus into increasing the means of production and living standards
rather than stifling social prosperity.
NOTES AND REFERENCES
- I discuss Patten and other
theorists of increasing returns in Economics and Technology in
19th-Century American Thought: The Neglected American Economists
(New York: Garland Press, 1975). For more biographical details see
Daniel M. Fox, The Discovery of Abundance: Simon N. Patten and
the Transformation of Social Theory (Ithaca, 1967).
- Simon Patten, "The
Reconstruction of Economic Theory," reprinted in Simon
Patten, Essays in Economic Theory ed. Rexford Guy Tugwell (New
York: 1924, Knopf): 274, 278f. See also Patten's Development
of English Thought (New York: Macmillan's 1899):339.
- William J. Baumol, "Rapid
Economic Growth, Equitable Income Distribution, and the Optimal
Range of Innovation Spillovers," in George L. Perry and James
Tobin, eds., Economic Events, Ideas, and Policies: the 1960s
and After (Washington, D.C.: The Brookings Institution,
2000):27f.
- The statistics, based on
C.B.O., Historical Effective Federal Tax Rates: 1979 to 2003
(December 2005), are summarized in Isaac Shapiro and Joel
Friedman, "New Unnoticed CBO Data Show Capital Income has
Become Much More Concentrated at the Top," Center on Budget
and Policy Priorities, January 29, 2006. The CBO study defines "capital
income" as "interest, dividends,, rents, and capital
gains."
- Baumol, "Entrepreneurship:
Productive, Unproductive, and Destructive," Journal of
Political Economy 98 (1990):893-921.
- Employee Benefit Research
Institute (Washington), as of May 2006.
- Jeff Chester, "The End of
the Internet?" http://www.thenation.com/doc/20060213/chester
[posted online on February 1, 2006]. He adds that FCC chairman
Michael "Powell and his GOP majority eliminated longstanding
regulatory safeguards requiring phone companies to operate as
nondiscriminatory networks (technically known as "common
carriers"). He refused to require that cable companies, when
providing Internet access, also operate in a similar
nondiscriminatory manner."
- Henry George, The Science
of Political Economy [1894, posthumous] (New York: 1992). Book
II, Ch. 14: The Two Sources of Value (259-261).
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